Multipliers

We are producing more with fewer workers; U.S. employment is below the pre-recession peak of January 2008 but output (real GDP) is 1.2% higher. Employment in the private sector and state and local government has declined over the past four years while Federal employment has increased. Since January 2008:

Private sector employment declined by 4.5%

Federal government employment increased by 3.4%

State government employment declined by 1.6%

Local government employment declined by 2.8%

Is the decline in state and local government employment a drag on the economy as Paul Krugman has argued? Or have state and local governments, like the private sector, become more efficient and deliver more and better quality services with fewer employees? This is impossible to tell from National Income Accounts data which only measure the cost of government spending and not the value of the government services provided.

It is important to put the recent declines in state and local employment into perspective. In the past fifteen years local government employment has grown almost twice as fast (17.5%) and state government employment has grown slightly faster (10.3%) than private sector employment (9.1%). State and local government has grown relative to the private sector for decades.

The recovery/stimulus legislation was designed to bolster state and government spending. However, as John Taylor testified to Congress, state and local governments used stimulus funds largely to reduce borrowing rather than increase expenditures.

Paul Krugman argues for more state and local government spending on goods, services and investment. (He admits that “safety-net spending … has soared in this slump.”) Keynesians believe that if spending were $340 billion higher (about 2% of GDP), GDP would be 3% higher due to the “multiplier” effect and the unemployment rate would be 1.5% lower. A “multiplier” argument is a smokescreen for the real debate about the appropriate size and scope of government. Some state and local government spending/employment cuts make sense if they eliminate waste and duplication but that is the opposite of what “multiplier” calculations would conclude.

In addition many leading economists such as John Cochrane and John Taylor are skeptical of large multipliers for stimulus spending. More importantly, the “multiplier” argument says nothing about which programs should be expanded and whether any programs should be cut. The emptiness of a “multiplier” justifcation for government spending is clear when one recognizes that Keynesians believe that government reductions in waste and fraud would lower GDP and raise the unemployment rate.

One of the most important election issues is the debate over the proper size and scope of government. The debate would be more informative if it focused on the direct costs and benefits of government programs, assumed that programs must be paid for even if financed through bonds, and did not rely on possible “multiplier” effects to justify spending.